Systems Analysis and Design

Strategies for cost-benefit analysis

(Additional notes)

Strategies for cost-benefit analysis

Payback Analysis
Accumulated Benefits equal Accumulated Costs

Return on Investment Analysis

% of (total benefits total costs) / (total costs)

Net Present Value Analysis

Value of a dollar years from now based on a discount rate
CT026-1 Systems Analysis and Design The traditional systems development lifecycle

Slide 31 (of 43)

Payback Analysis
Payback period
Four step process
[1] [2] Determine the systems initial development cost Determine annual operating costs

[3]
[4]

Estimate the annual benefits

Find the payback period by comparing total costs to accumulated benefits

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 5 (of 30)

Payback Analysis
Development Cost & Operating Cost

Development cost Operating Cost

Year
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Costs $ 60,000.00 $ 17,000.00 $ 18,500.00 $ 19,200.00 $ 21,000.00 $ 22,000.00 $ 23,300.00

Cumulative Cost $ 60,000.00 $ 77,000.00 $ 95,500.00 $ 114,700.00 $ 135,700.00 $ 157,700.00 $ 181,000.00

B $ 3,0 $ 28,0 $ 31,0 $ 34,0 $ 36,0 $ 39,0 $ 42,0

Slide 6 (of 30)

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Payback Analysis
Development Cost & Operating Cost

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 7 (of 30)

Payback Analysis
Annual Benefits

Cumulative Year Cost $ 60,000.00 Year 0 $ 77,000.00 Year 1 $ 95,500.00 Year 2 $ 114,700.00 Year 3 $ 135,700.00 Year 4 $ 157,700.00 Year 5 $ 181,000.00 Year 6
CT026-1 Systems Analysis and Design

Benefits Costs $ 60,000.00 3,000.00 $ 17,000.00 28,000.00 $ 18,500.00 31,000.00 $ 19,200.00 34,000.00 $ 21,000.00 36,000.00 $ 22,000.00 39,000.00 $ 23,300.00 42,000.00

Cumulative Cumulative Cost Benefits Benefits $ 60,000.00 3,000.00 $ 3,000.00 $ 77,000.00 31,000.00 $ 28,000.00 $ 95,500.00 62,000.00 $ 31,000.00 $ 114,700.00 96,000.00 $ 34,000.00 $ 135,700.00 132,000.00 $ 36,000.00 $ 157,700.00 171,000.00 $ 39,000.00 $ 181,000.00 213,000.00 $ 42,000.00
Slide 8 (of 30)

C $ $ $ $ $ $ $

The traditional systems development lifecycle

Payback Analysis
Annual Benefits

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 9 (of 30)

Payback Analysis
What it is and what it is not: not the point when the current benefits equal current costs is the point where accumulated benefits equal accumulated

costs
How to compute Use a spreadsheet

Design the spreadsheet and label the columns and rows

Enter the cost and benefit data for each year Enter the formulas to calculate cumulative costs and benefits

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 10 (of 30)

Payback Analysis

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 11 (of 30)

Payback Analysis
Disadvantages:

places all the emphasis on early costs and benefits

ignores the benefits received after the payback period Conclusion: poor tool for comparing or ranking several projects

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 12 (of 30)

Payback Analysis

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 13 (of 30)

Quick Review Question

What is payback analysis and what does it measure?

What is payback period?

What is the formula to calculate the payback period?

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 14 (of 30)

Return on Investment Analysis

Disadvantages:
ROI only measures the overall rate of return for the total period

Annual rates can vary considerably

ROI ignores timing of costs and benefits

How to compute: Set up the worksheet and enter cost and benefit data Overall cost and benefit totals are required Add a formula to calculate ROI, which is total benefits minus total costs, divided by total costs

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 16 (of 30)

Return on Investment Analysis

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 17 (of 30)

Quick Review Question

What is ROI analysis and what does it measure?

What is the formula to calculate ROI?

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 18 (of 30)

Present Value Analysis

Time Value of Money A dollar today is worth more than a dollar one year from now.

Present value of a future dollar the amount of money that when invested today at some specified interest rate (discount rate / opportunity cost) would grow exactly to one dollar at that point in the future

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 19 (of 30)

Present Value Analysis

Formula: Present value of a dollar n years from now at a discount rate of i is calculated as follows : n PV = 1 / (1 + i)

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 20 (of 30)

Present Value Analysis

Present Value Adjustment Factors: are based on a specified interest rate called the discount rate. Each company determines its own acceptable rate of return for an information systems project are printed in tables called present value tables

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 21 (of 30)

Present Value Analysis

Present Value Table:
6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592 0.558 8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 1.424 0.386 12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270
Slide 22 (of 30)

PERIODS 1 2 3 4 5 6 7 8 9 10
CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Present Value Analysis

How to compute: Enter the unadjusted cost and benefit values and the discount factors for each year Enter a formula to produce an adjusted value for each cost and benefit entry to produce an adjusted value, the formula should multiply the cost or benefit value times the discount factor Copy your formula to the other cost and benefit cells to adjust the other value Calculate the net present value by subtracting the total adjusted costs from the total adjusted benefits

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 23 (of 30)

Present Value Analysis

How to compute:

Benefits Present Value Factor (12%) Present Value

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 3,000.00 28,000.00 31,000.00 34,000.00 36,000.00 39,000.00 42,000.00

Total

1.000

0.893

0.797

0.712

0.636

0.567

0.507

3,000.00 25,004.00 24,707.00 24,208.00 22,896.00 22,113.00 21,294.00 143,222.00

Costs 60,000.00 17,000.00 18,500.00 19,200.00 21,000.00 22,000.00 23,300.00 Present Value Factor (12%) 1.000 0.893 0.797 0.712 0.636 0.567 0.507 Present Value 60,000.00 15,181.00 14,744.50 13,670.40 13,356.00 12,474.00 11,813.10 141,239.00 Net Present Value 1,983.00
CT026-1 Systems Analysis and Design The traditional systems development lifecycle Slide 24 (of 30)

Present Value Analysis

Advantages: not only considers all costs and benefits, but adjusts the values based on timing Disadvantages: depend on future estimates are only as reliable as the forecasts themselves

Conclusion: Many companies use all three methods to evaluate projects

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 25 (of 30)

Quick Review Question

What is present value analysis and what does it

measure?
What is the meaning of the phrase, time value of money?

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 26 (of 30)

Summary
Payback Analysis
Accumulated Benefits equal Accumulated Costs

Return on Investment Analysis

% of (total benefits total costs) / (total costs)

Net Present Value Analysis

Value of a dollar years from now based on a discount rate

CT026-1 Systems Analysis and Design

The traditional systems development lifecycle

Slide 28 (of 30)